What is Longevity Risk?
Longevity risk is the risk that the pension fund must pay out the accrued pensions for longer than expected. Suppose the pension fund assumes that they must pay out a pension for fifteen years on average. But life expectancy rises and people grow older than previously thought. As a result, the pension fund for example must pay out a pension for seventeen years on average.
What is a longevity shock?
When you retire, you receive an retirement pension every month for as long as you live. The pension fund calculates how much money is needed to pay you this pension from the moment you retire. The pension fund looks at various aspects, such as the best possible estimation of the average life expectancy. The money that has been set aside to pay the pensions now and in the future is called the provisions.
A change in life expectancy has consequences for the provisions. People in the Netherlands are growing steadily older, so life expectancy is rising. It is possible that the average life expectancy rises more than could have been estimated in advance. In this case, the pension fund must pay out the pensions during a longer period. The provisions will then not be sufficient and must be increased. We call this a longevity shock.
How does the pension fund determine a longevity shock?
The pension fund calculates the effect of a change in life expectancy on the provisions. The pension fund uses the mortality tables of the Actuarial Association (Actuarieel Genootschap/AG) for this purpose These tables are published every two years.
How does the pension fund deal with longevity shock?
The board of the pension fund has drawn up guidelines for setting off the shortfall due to a longevity shock. The pension fund covers this shortfall with the money set aside for indexation. Indexation is a pension increase that is awarded to adjust pensions to compensate for rising prices. The pension fund tries to adjust the pensions every year to compensate price increases, so that you can continue buying the same amount of products and services with your pension.
If a longevity shock occurs, the amount of available money remains the same, but must be spread over more years. People are going to enjoy a longer retirement. This means that extra money is needed to be able to make the pension payments at the level previously expected.
What does this mean for you?
The chance of receiving full or partial indexation is decreasing because of the longevity risk. Indexation is also applied to pensions that are not yet being paid out. In other words, the longevity risk also exists when your pension is not yet in payment.